Deficit and debt ceiling

Before we talk about the debt ceiling, it's important to realize the difference between the deficit and the debt. Because these words are thrown around and it's clear that they're related, but sometimes people might confuse one for the other. The deficit is how much you overspend in a given year, while the debt is the total amount, the cumulative amount, of debt you you've gotten over many, many years. So let's take a look, I guess a very simplified example, let's say you have some type of a country. And that country spends, in a given year, $10. But it's only bringing in $6 in tax revenue. So it's bringing in taxes. It's only bringing in $6. So this country in this year, where it spends $10, even though it only has $6 to spend, it has a $4 deficit. Def is the short for deficit. And well, let me just write it out. You might think it's defense or something. It has a $4 deficit. And you might say, well, how does it spend more money that it brings in? How can it actually continue to spend this much? Where will it get the $4 from? And the answer is, it will borrow that $4. Our little country will borrow it. And so the debt, maybe going into this year, the country already had some debt. Maybe it already had $100 of debt. And so in this situation, it would have to borrow another $4 of debt. And so exiting this year, it would have $104 of debt. If the country runs the same $4 deficit the year after this, then the debt will increase to $108. If it runs another $4 deficit, than the debt will increase to $112. Now that we have that out of the way, let's think about what the debt ceiling is. So you could imagine, the United States actually does. It's continuing to run a deficit. It's continuing to spend more than it brings in. And actually, for the United States, these ratios are appropriate. For every dollar that the United States spends right now, 40% is borrowed. Or another way to think about it, it only has 60% of every dollar that it needs to spend right now. So it has to go out into the debt markets and borrow 40% to keep spending at its current rate. And so if it's continuing to borrow, you could imagine that the debt keeps on increasing. So let me draw a little graph here. So that axis is time. This axis right over here is the total cumulative amount of debt that we have. We continue to have to borrow 40% of every dollar that we're spending. And so our debt is continuing to increase. And Congress has the power, or Congress has the authority, to essentially limit how much debt we have. So right now we have a current debt limit of $14.3 trillion. And even though Congress has this authority, the way that it's worked in the past, is this kind of just a rubber stamp. Congress has just always allowed the debt ceiling to go up and up and up to fund our borrowing costs. And if you think about it, that kind of makes sense because right now Congress is the one that decides where to spend the money. What are the obligations. And so the debt ceiling is like, OK, we've already agreed what you have to spend your money on. Congress is the one that figures out what we spend our money on, and what our taxes are. And so they say, look, we've already determined how much you have to borrow. It would seem kind of ridiculous for us after we've determined how much you borrow to say that you cannot borrow it. You cannot you cannot actually do what we've told you to do. And so historically, Congress has just kind of gone with the flow. They said, OK, yeah we've told you we need to borrow more money to execute-- the executive branch has to run the government-- for you to actually run the government based on the budget we told you. So they just keep upping it. And the last time the debt ceiling was raised was actually very recently, February 12, 2010. It was raised from $12.3 trillion, point actually $12.4 trillion to the $14.3 trillion. And this happens pretty regularly. It's happened 10 times since 2001, 74 times since 1962. So it's just a regular operating thing. And right now the Obama administration says, look, we've actually come up against our debt ceiling. We want to raise it, and ideally for the Obama administration, they want to raise it by about $2.4 trillion. So they want to raise it to $16.7 trillion, which will kind of put it off the table for a little bit. Put it past the elections so that we don't have to debate this anymore. The Republicans on the other the side, want to essentially use this, and this is a little bit unusual, to use this as leverage to essentially reduce the deficit. And not only to reduce the deficit, but it's in particular to reduce the deficit through spending cuts. And so that's why it's become this big game of chicken and why we're going up against this limit. Now, one thing that you may or may not realize is that we've actually already hit the debt limit, the current debt limit. And we hit that debt limit on May 16, 2011. I'm making this video at the end of July in 2011. And the only reason why the country's continuing to operate, and the only reason why the country has been able to continue to pay interest on its obligations, and pay issue social security checks, and support Medicare, and buy fuel for aircraft carriers, and all the rest, is that Geithner, who's the Treasury Secretary, has been able to find cash in other places, cash normally set aside for employee pensions and all the rest. And has essentially done a little bit of a bookkeeping, taking money from one place to feed another. But what he said, what he's publicly said, is that he won't be able to do that anymore as of August 2, 2011. So this right here is the date that everyone is paying attention to, August 2, 2011. According to Geithner, at that point, he won't be able to find random pockets of cash here and there and shuffle it around. And what he calls extraordinary measures. And at that point, the United States will not be able to fulfill all of its obligations. And so if you think about all of the obligations of the United States, this is a huge oversimplification here. So this bar represent all of the obligations. Some of those obligations are things like interest on the debt that it already owes. It already owes a huge amount of debt, $14.3 trillion. And things like social security, Medicare, defense, and then all of the other stuff that the country has to support, all of their other obligations. So if as of August 2, 2011, we cannot issue any more debt, and Geithner doesn't have any extra cash laying around with these extraordinary measures, then, if those are the only options on the table, The only option is to somehow reduce some of these things by 40%. Because 40% of every dollar we used to spend on all of these obligations, 40% are borrowed. And so something over here is going to give. We're not going to fulfill our obligations to one or more of these things, all of these things that we are legally obligated to fulfill. That Congress has said, these are the things that the United States should be spending its money on. And so at that point, it is perceived that we would have to default. And a default actually would be on any of its obligations. But in particular, we could be, especially if we have to cut everything by 40%. And we don't want to see retirees not be able to get evicted from their houses, or aircraft carriers not have fuel, or whatever else. We might defer, or try to restructure, or do something weird with our debt. In which case, we would be defaulting. And I want to be clear, a default, it's usually referred to not fully paying the interest on debt that you owe. But a default would be any of its obligations. The United States has this AAA rating. If the United States says it's going to give you a Social Security check, you trust that. If the United States says that it's going to pay for that Medicare payment, you trust that. If it says it's going to give you an interest payment, you trust that. All of a sudden, if United States does not fulfill any of those obligations, then all of the obligations becomes suspect. And the reason why this is a big deal, as you can imagine, if you borrow money, you've always been good at paying back that money, you're going to pay lower interest than other people would have to pay. But all of a sudden, for whatever reason, one day you default. You either delay your payment, or you say you don't have the cash to pay your payments, then people's like, wow you're a much riskier person to lend money to. So now I'm going to increase the interest rates on you. And so the perception is if the United States were to default on its debt, or any of its obligations, that interest rates would go up. And the reason why this would really not great is because it would make the debt and the deficit even worse. Then this chunk is going to have to grow. Our obligations are on debt. As new debt gets issued, we're gonna have to pay more and more interest. So it's going to just make matters worse. It's going to make the deficit worse. And on top of that, it's not just that the government's debt, the interest on the government's debt will go up, but interest on all debt in the United States will probably go up. Because government debt is perceived to be the safest, it's the benchmark. A lot of other debt contractors are actually tied to government debt. So you'll have interest rates throughout the economy go up, which is exactly what you do not want to happen when you are either in a recession, or when you are recovering from a recession.